Moore on Pricing: Keep your eyes on rail rates

The U.S. railroad industry, consisting of over 600 large and small service providers, has successfully engineered itself into a viable and largely profitable segment of the nation’s logistics marketplace.

This mode is a critical element for “captive” shippers who are dependent on railroads for transport such as coal and some agriculture and chemicals, and a significant player in the trailer/container transport market both domestically and internationally. However, rail shippers and those who would consider rail as an alternate mode, need to be paying attention to some forces that may have a significant effect on pricing in the coming years.

This month, the stock analysts and talking heads on financial shows are raising alarms about the large coal-carrying railroads. After a very positive first quarter and a fair second quarter, some rail carriers are lowering earnings estimates according to the current banter. 

The reason given by at least one of the Class I railroads is the transition to natural gas by the utility companies. This may be a good thing for coal shippers who want to negotiate unit train rates, but for non-coal shippers it possibly signals more than a temporary slacking of demand.

In the years ahead, the U.S. is expected to increase the use of natural gas for utilities and industry due to price and environmental pressures. Keep in mind that natural gas uses pipes, not rail, which translates into less demand for transportation of coal that represents a substantial portion of the revenue and margins of the U.S. rail carriers.

When the rails feel revenue and margin pressure they historically turn first to captive shippers—steel, heavy equipment, agriculture, and chemicals—and then to intermodal markets for additional revenues through price increases. In addition to this scenario, there is the potential competitive price pressure on transcontinental intermodal rail movements due to the widening of the Panama Canal that will increase the capacity of water carriers.

Some railroads may very well experience less than stellar improvement due to the economy, the loss of coal revenues, downward pressure on intermodal pricing, as well as the stabilization of oil-based fuel prices putting a combined pressure on the railroads’ revenues. The ones to watch are the Class I railroads who account for 90 percent of the $50 billion in annual rail spend. Shippers will need to keep an eye on their service providers to see how they’re managing these shifts in the market.

Rail shippers who are non-captive need to dust off alternate modal routing plans to counter upward price pressure. Rail-dependent shippers need to refresh the supply and distribution models with information on alternate routes, alternate production sites, and rail-water or rail-highway combinations that might introduce some competition for service providers. 

One popular option is for commodity shippers to swap rail-served customers with competitors who are closer to the customer’s plants enabling shorter highway delivery.  In this strategy, the railroads lose the freight as both companies satisfy demand by a ton-for-ton exchange in local markets. 

In short, shippers need to pay attention to the market forces affecting their service providers and realize that if they are threatened, your company’s ability to compete may be threatened as well. It’s time for rail shippers to step up and get creative when planning over the next six to eight months.